14A — November 9 - 22, 2012 — Mid Atlantic Real Estate Journal
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By Mark Scott, Commercial Mortgage Capital The case for lower multifamily cap rates
A
ttend any number of multifamily con- ferences around the
There are number of factors driving this compression, in- cluding a healthy amount of cash that is ready to return to the market; record low inter- est rates; and a desire among both GenerationY consumers and the Baby Boomer genera- tion (some 76 million strong) to forgo homeownership in favor of renting. But what’s arguably most important to the cap rate debate will be the fate of the home mortgage interest deduction. First, let’s follow the cash flow. There is a strong sta-
ble of Real Estate Invest- ment Trusts that have large amounts of cash they are looking to deploy, and multi- family is currently the most stable asset class available. In September, the Multifam- ily Production Index (MPI), released by the National As- sociation of Home Builders (NAHB), improved for the eighth consecutive quarter with an index level of 54. It is the highest reading since the second quarter of 2005. The MPI, which measures builder and developer senti-
ment about current condi- tions in the apartment and condominium market on a scale of 0 to 100, rose from 51 in the first quarter to 54 in the second quarter. We have seen top-quality New Jerseymultifamily rent- al product trade anywhere from a 4% to 4.8% cap – an indication that this product is indeed favored by inves- tors. This rate is not entirely surprising given that these are best-in-class buildings that will certainly see rents rise. However, we are also
seeing an increased inter- est among investors looking to purchase older product at a lower basis since there is ultimately more upside following either a cosmetic renovation or major rehab. For these value added invest- ment opportunities, expect to see cap rates decline. What’s more, the low interest rate environment could also dip cap rates even deeper, and it appears that this will remain in place for the next several years. In September, the Fed- eral Reserve announced that it would keep interest rates near-zero even if the economy starts to recover. One of the most significant factors driving multifam- ily rental rates is a multi- generational trend toward leasing and away from ho- meownership. Specifically, GenerationY consumers who have been hit hard by the recession may not be able to purchase a mortgage, and many enjoy the convenience of urban rental space. The Baby Boomer generation is also pursuing rental housing, as many Boomers look for living options that require less personal maintenance or seek to convert their home eq- uity into much-needed retire- ment income. Both of these demographics are providing a hefty boost to the apartment rental market, which should drive down cap rates. But the biggest wildcard in this whole cap rate debate might just be the home mort- gage interest tax deduction. The current deduction, which is lauded by most homeown- ers, allows them to remove the interest they paid on a mortgage. However, flat-tax advocates favor terminat- ing this deduction, and U.S. lawmakers on both sides of the aisle have been discuss- ing a variety of tax reform structures that could involve the elimination of the mort- gage interest tax deduction. Ultimately, if Washington is successful in reducing or eliminating the interest deduction, the multifam- ily rental market will grow stronger, which could herald in an era of even lower cap rates. Mark M. Scott is princi- pal of Commercial Mort- gage Capital in Livings- ton, NJ. n
Tri-State re- gion and cap r a t e s a r e sure to be a topic of dis- cussion. But while many suggest that cap rates for multifamily
Mark Scott
rental properties will flatten in the future or even rise, I would argue that they can (and likely will) go lower.
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